By Michael Lelyveld
Mountains of corporate debt are casting a shadow over China’s economy after a series of shocks in the stock market during the past month.
On July 18, Reuters reported that China’s corporate debt has climbed to a new high of U.S. $16.1 trillion (100 trillion yuan), making it “a much greater threat” to the country’s economy than the stock market’s near-crash.
The estimate, based on a survey of over 1,400 companies, follows a similar finding for the 2014 debt level by ratings agency Standard & Poor’s (S&P’s) in a report released days before.
China’s corporate debts are already double those of the United States, according to Reuters. The debts are now equal to about 160 percent of China’s gross domestic product (GDP), the studies said.
Debt burdens have been climbing in recent years and appear to be accelerating rapidly.
In 2013, corporate debts totaled U.S. $14.2 trillion (88.2 trillion yuan) or 120 percent of GDP, according to S&P’s.
Last year, JPMorgan Chase & Co. estimated the debt as 137 percent of GDP in the third quarter. The Bank for International Settlements put the figure for 2013 at 125 percent.
The liabilities stood at just 90 percent of GDP in 2007, JPMorgan Chase said in its report last year.
S&P’s now expects China’s corporate debt to reach U.S. $28.8 trillion (178.9 trillion yuan) in the next five years.
The rising numbers suggest a problem that will be harder to manage than the stock market challenge.
In its report, S&P’s cited “high concern in Chinese real estate and default risk,” as well as “the growing vulnerability of corporate credit in China.”
“The Chinese credit growth rate still remains faster than most, but the corresponding risks are rising as well,” said Jayan Dhru, the agency’s global head of corporate ratings and infrastructure.
Dhru cited the “opaque nature” of China’s markets and the debt-to-GDP ratio among factors contributing to “relatively high” credit risks.
Chunk of debt
The biggest chunk of the debt is owed by state-owned enterprises (SOEs), complicating risk assessments for the overall economy.
According to ambiguous Ministry of Finance figures released in January, SOE liabilities rose 12.2 percent last year to 66.56 trillion yuan (U.S. $10.7 trillion), although the figure was actually lower than the debt level of 67.1 trillion yuan (U.S. $10.8 trillion) reported for 2013.
Either way, SOEs account for about two-thirds of China’s corporate debt problem.
Kent Troutman, research analyst at the Peterson Institute for International Economics in Washington, said the SOE debt affects how the totals may be counted and how the risks are assessed.
“Some folks count the SOE debt as corporate debt and some count it as part of the contingent liabilities of the government,” said Troutman.
If the SOE debts are treated as corporate, then the new estimates appear reasonable, he said. But there are arguments for counting the debts as an obligation on the government’s books.
“Because the government either implicitly or explicitly owns a large share of the SOEs, they may ultimately be responsible,” Troutman said.
Where the burden would ultimately land as a repayment risk has yet to be determined.
In 2013, China had 155,000 SOEs, including 52,000 owned by the central government. The rest belonged to local governments, according to the Ministry of Finance.
The picture is further complicated by local government debts, which Beijing has been trying to restructure through a combination of debt swaps and bond offerings.
In April, UBS head of China economic research Wang Tao estimated that 10 trillion yuan of the 21 trillion yuan (U.S. $1.6 trillion of $3.3 trillion) owed by local governments at the end of last year could be classified as corporate debt.
China’s debts have swelled with the economic expansion that followed the central government’s 4-trillion-yuan (U.S. $644-billion) stimulus plan of 2008, which staved off the effects of the global slump.
While the plan succeeded in assuring economic growth, it did so by funding a binge of wasteful infrastructure projects with easy bank loans, leaving a hangover of debt.
Greater restraint and concerns about shadow banking and sustainable development gave way this year to worries about declining economic growth, prompting a push for more lending and local infrastructure projects again.
“It is a 180-degree reversal of the fiscal policy from tightening to loosening,” said Deutsche Bank economists in a May report cited by Bloomberg News.
Looser lending may have eased the real estate slump and the economic slowdown, but the effects are likely to drive up corporate debts and default risks in some of the same inefficient sectors that were saved by the last stimulus plan.
Troutman says the new debt level numbers amount to more than a right-pocket-left-pocket issue, in which the government effectively owes itself money for SOE liabilities that will ultimately be supported.
“It’s not all completely circular. Especially within specific sectors of the economy, these are real debts that have been taken on and are unlikely to be paid,” he said.
Premier Li Keqiang has signaled a tolerance for a limited level of defaults as a “moral hazard” check against reckless lending and debt accumulation.
In April, the Kaisa Group Holding Ltd. real estate development firm defaulted on a U.S. $52-million interest payment, sending chills through the bond market but without widespread contagious effects.
A day later, power equipment maker Baoding Tianwei Group Co. also missed a 85.5-million yuan (U.S. $13.8-million) bond interest payment, becoming the first SOE to default on the domestic market.
“Defaults by non-strategic, commercially unviable SOEs can help to instill greater market discipline and reallocate capital more efficiently in the economy,” Fitch Ratings said in a report three months ago.
The government is seen as unlikely to take the same hands-off approach in case of a major SOE bankruptcy, although critics have long argued that private businesses can only flourish if heavily indebted SOEs are allowed to fail.
Even more cautious
Given the continuing trouble in the stock market, the government seems likely to be even more cautious about letting troubled corporate debtors go under.
Beijing’s interventionist response to the stock threat also suggests that the government may be better prepared to step in, if a major default looms.
Conversely, regulators could order more debt discipline and accept more default risk in coming months if they believe market stability has been achieved.
Troutman said the effects of a default could trigger another reaction in stocks. But he added, “I gave up making predictions on the Chinese stock market a long time ago.”
The rising debts are likely to show up in higher non- performing loan (NPL) figures, although ratios have remained relatively low, due in part to the greater volume of loans.
At the end of last year, NPLs accounted for just 1.29 percent of commercial bank lending and 1.64 percent for all banks, according to the China Banking Regulatory Commission (CBRC).
In the first quarter of 2015, the commercial bank NPL ratio climbed to 1.39 percent, the CBRC reported. The ratios have been rising for the past four years, Troutman said.
Last month, UBS noted in a report that the NPL counts would be considerably higher if they included loan write-offs, which banks have been granting to keep their ratios down, Barron’s Asia said.